Examine the way in which a small increase in t will affect

Reference no: EM13952760

A person has an objective function Eu(y) where u is an increasing, strictly concave, twice-differentiable function, and y is the monetary value of his final wealth after tax. He has an initial stock of assets K which he may keep either in the form of bonds, where they earn a return at a stochastic rate r, or in the form of cash where they earn a return of zero. Assume that Er > o and that Pr{r < o}=""> o.

1. If he invests an amount (3 in bonds (o (3 K) and is taxed at rate t on his income, write down the expression for his disposable final wealth y, assuming full loss offset of the tax.

2. Find the first-order condition which determines his optimal bond portfolio.

3. Examine the way in which a small increase in t will affect.

4. What would be the effect of basing the tax on the person's wealth rather than income?

Reference no: EM13952760

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